No shortage of borrowing options should the ‘PWLB tap be turned off’
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PWLB borrowing may be blocked, but there are other ways to access credit. David Green surveys the options.
As the consultation on PWLB future lending terms draws to a close, some authorities are turning their mind to their borrowing options, should they end up on HM Treasury’s naughty step.
While the government is hoping to stop “debt for yield” activity, it correctly realises that cash is completely fungible so it can be quite unrealistic to identify which assets have been funded by borrowing rather than say capital receipts. “Capital for yield” would be a better description, and authorities are rightly concerned that seemingly innocuous activity could fall foul of the proposed new lending terms. Replacing the roof of an investment property using a sinking fund established just for that purpose appears to put a bar on accessing to PWLB to build schools, care homes and council houses for a whole year.
Options
So, what are the alternatives? Apart from PWLB, the main growth area for borrowing last financial year was loans from other local authorities, a market which now tops £14bn. Most of these loans are for less than one-year, reflecting the very low interest rates payable, and most will be re-borrowed on maturity when rates will almost certainly still be very low. Over the long-term, a rolling book of short-term loans leaves you exposed to the risk of interest rate rises but also allows you to benefit if rates stay low or even turn negative.
Non-PWLB options for long-term loans haven’t been too popular in recent years. The Municipal Bonds Agency issued its inaugural bond in March, a five-year floating rate note priced half-way between the PWLB variable rate and short-term local authority loans. The agency hopes to issue longer-term fixed rate bonds for local authorities in the coming years. Potential borrowers need to be aware of the risks associated with making contribution loans and guaranteeing payments to bondholders, and the accounting complications they cause.
We started to see renewed interest in lending to local authorities from a couple of high street banks earlier this year. Loans are now offered without the complication of lender options so popular a decade or two ago. But coronavirus has caused the banks to focus elsewhere for the time being.
Preferences
A few authorities have borrowed from pension funds and insurance companies recently. These institutions tend to have large sums to invest in relatively safe places, and some like the small increase in risk and larger increase in return available compared with lending to central government.
Community bonds hit the news last week, offering local residents the opportunity to finance public services directly. At current PWLB rates, there is a sweet spot where the interest rate can be favourable for both parties. You’ll need a technology solution to administer payments and record keeping for hundreds or thousands of small investors.
Leasing and income strips remain viable alternatives to borrowing. These will finance specific assets, often with the option to buy them outright and the end of the term. There may be accounting complications if the transaction counts as a sale and leaseback, or if the payments are index-linked, but they can still be value for money.
So, there is no shortage of alternative sources of funds if the PWLB tap is turned off. But the unanswered question is how many would still lend to you if even your lender of last resort won’t. Currently, no local authority should ever default on a loan because the government will always lend it the cash to repay the original lender. When that is no longer the case, the credit assessment will be all the more important. Based on recent headlines, not all authorities will pass that test.
David Green is strategic director at Arlingclose Limited.
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